Long-term holders of gold should expect a positive correlation to inflation, but a major report published by Credit Suisse today suggested bullion holders might be disappointed by long-term real returns.

The good news is, gold is one of only two assets since 1900 to have positive sensitivity to inflation (of 0.26).

Only inflation-linked bonds had more – 1.00, as expected.

By contrast, when inflation rises 10%, bond returns have fallen an average 7.4%; Treasuries fell 6.2%, and equities lost 5.2%. Property fell by between 3.3% and 2%.

The academic authors of the report from the London Business School drew a distinction between ‘inflation beating’ assets, and ‘inflation hedging’ ones.

‘Inflation hedging’ instruments have a high correlation with inflation and higher returns when inflation is high, but their long-term return may be low (developed world linkers, gold).

‘Inflation beating’ assets are different. They have higher long-term returns than CPI – for example equities – but they may be a poor hedge in times of high inflation.

Elroy Dimson, one of the report’s co-authors from the London Business School, added it was not at all clear the equity risk premium was linked to inflationary environments.

“One must be careful. Equities beat inflation over the long term – which represents the risk equity investors have take – but it is not clear that the risk they took on was primarily the risk of inflation.

“Inflation was just a small part of the constellation of risks. For inflation hedging, you would have to ask: Is the equity risk premium correlated to inflation?”

The answer above (negative sensitivity to inflation of 0.52) suggests the answer is: ‘it is not’.

Gold managed to increase its value across both extreme inflationary, and deflationary, scenarios.

The LBS academics analysed 2128 discrete years in 19 major countries (1900-2011), finding gold rose 12.2% in the most deflationary years – when average deflation was 26% – and also rose marginally in the most inflationary if those years, when CPI was jumping on average by 18%.

But there was a downside.

Since 1900 to 2011 bullion made real returns of only 1.3% a year, compared to shares’ 5.4% (MSCI World USD) and bonds’ 1.7%.

Paul Marsh, co-author of the report published jointly with Credit Suisse, said the lesson for investors was that equities are still better long-term investments, but they lost 12% of their real value in years when average annual inflation was highest (at 18%).

“Gold has given returns that are not very high, but when you have had inflation, gold has been a good asset to have. For institutions gold would have less of a role then it might for individual investors,” he said.

He added: “Gold is a hedge against inflation on average, but it is a volatile asset.”With a standard deviation of 12.4%, gold was second only to shares (17.7%). It beat bonds (10.4%), housing (8.9%) and Treasuries (4.7%).